CHICAGO – The Financial Industry Regulatory Authority has begun examining municipal bond dealers’ compliance with the Municipal Securities Rulemaking Board’s recently released interpretive guidance to Rule G-17, which spells out underwriters’ fair-dealing obligations to municipal issuers.
Cynthia Friedlander, FINRA’s associate director of fixed income regulation, told attendees at Bond Dealers of America’s annual National Fixed Income Conference here that FINRA examiners will first determine if muni bond dealers have created written supervisory procedures specifying how they will comply with the guidance, which took effect Aug. 2.
FINRA’s examiners also will focus on firms’ compliance with rules designed to prevent pay-to-play, bid-rigging, and yield chasing as well as rules on disclosure, suitability, retail order periods, fair pricing, fair dealing, and gifts and entertainment, she said.
“What we are looking for initially is a good faith effort to comply with that rule,” said Friedlander, referring to the MSRB’s G-17 guidance. She made the comments to roughly 200 executives from dealer firms during a morning session about the self-regulator’s muni market compliance and enforcement priorities.
The MSRB’s G-17 guidance requires underwriters to disclose information about their roles, compensation, conflicts of interest, incentives and the existence of swaps tied to the bonds. Underwriters must also inform issuers that they do not have a fiduciary duty to put issuers’ interests above their own.
In addition, the guidance requires underwriters to disclose material aspects of some deals as well as the risks and incentives of complex financings such as swaps that they recommend in negotiated transactions.
The guidance also sets timing requirements: underwriters must disclose the “arm’s-length” nature of their role early, but can disclose conflicts of interest, compensation and other details after being hired.
Friedlander acknowledged that the guidance is new and that firms may need assistance in understanding their obligations. FINRA wants to make sure firms understand how to comply and will consult with the MSRB to discuss instances of possible noncompliance, she said.
FINRA also has in its sights on compliance with the MSRB’s new Rule G-43 on broker’s brokers and related interpretive guidance, which takes effect Dec. 22. G-43 requires broker’s brokers to take certain steps to ensure they obtain fair and reasonable prices when conducting secondary-market “bid-wanted” auctions.
Friedlander cautioned dealers to also familiarize themselves with the MSRB’s Rule G-37, which is designed to prevent dealers from engaging in pay-to-play practices. The rule prohibits dealers from engaging in negotiated offerings with an issuer for two years if it or its muni finance professionals make significant contributions to issuer officials who can influence the award of bond business.
“I know its expedient for firms to hire people who are politically connected, but you also have the supervisory duty over those people,”
she said. Friedlander urged firms to ensure staff have been trained. “You need to have good training and good supervision to make sure your employees understand the implications of G-37,” she added.
Friedlander mentioned the SEC’s recent pay-to-play case against Goldman Sachs & Co., which agreed to pay nearly $12 million in penalties, interest and disgorgement of ill-gotten gains late last month to settle charges. The SEC said a Goldman vice president conducted campaign activities for former Massachusetts treasurer Timothy Cahill starting in 2008. The firm then violated G-17 by underwriting 30 Massachusetts bond issues within two years after that, the SEC found.
Allyson Dodd, field operations group manager in the Internal Revenue Service office of tax exempt bonds, told attendees that the IRS has been examining the process by which new-issue muni prices are established.
She said IRS officials have increased their use of trading data from the MSRB’s EMMA system and data from private venders to identify pricing anomalies and cases in which dealers may have been given priority for bonds over individual investors.
Dodd recommended that issuers hold pre-sale discussions with their underwriters to understand how initial offering prices will be established and to determine how long the bonds will be offered to the public. Issuers should also compare their bonds’ prices to those of other comparable, recently-sold munis, she said.
In recent months, several bond lawyers have amended their closing practices to require that underwriters meet with issuer officials after bond sales to explain each trade in the primary offering that was not sold at the initial public offering price.
“Such a discussion helps the issuer evaluate the effectiveness of the pricing economically, as well as identify if there are any potential concerns about the correct establishment of issue price for tax purposes,” Dodd said.